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Increasingly bullish prospects of gold stocks

Despite the recent weakness we are becoming
increasingly bullish about the prospects for gold stocks. Actually, it's
partly due to the recent weakness that we are becoming increasingly
bullish, because the extension of the downward correction makes it more
likely that the overall advance from the May low will last well into
next year.

We had thought that the most likely
alternative to the overall advance extending well into next year was an
intermediate-term peak late this year. But with the corrective action
that began in September having continued until the third week of
November there is now almost no chance of an intermediate-term peak by
year-end. The correction has been long enough and large enough to lay
the foundation for a rally lasting at least a few months.

We acknowledge that if there were another
2008-style market crash then gold stocks would be dragged down with all
other stocks, but a 2008 repeat is unlikely in the extreme. We will
continue to assess the evidence in real time, but at this stage we can't
envisage the monetary backdrop changing over the next few months in a
way that would give a 2008-style collapse a realistic chance. Also of
relevance is the general point that the next crisis is rarely, if ever,
similar to the last crisis. As things stand today, the last crisis was
the 'mother of all' deflation scares. It involved large declines in the
prices of all investments except the highest grade government bonds. We
suspect that the next crisis will involve a melt-up in gold-related
investments driven by rapidly-rising fear of what central banks and
governments are doing. In any case, the start of the next crisis is
probably more than a year away.

Moving on, the following weekly chart of
the XAU/SPX ratio is one way to illustrate the upside potential of gold
stocks relative to stocks in general, assuming that the long-term bull
market in the XAU/SPX ratio isn't over. This is a reasonable assumption,
because a) the long-term bull market in the XAU/SPX ratio shouldn't end
until the gold bull market comes to an end, and b) in our 1st October
and 29th October commentaries we explained why the gold bull market was
still years away from its ultimate top.

Given that the XAU/SPX ratio is coming off
its most oversold extreme of the entire bull market and is still near
the bottom of its long-term channel, it is reasonable to expect
substantial strength in the gold sector relative to the broad market
over the coming 12 months as the major trend shifts from massively
'oversold' to 'overbought'. This should result in a strong rally in the
gold sector even if the broad stock market is moderately weak. For
example, a decline to 1200 by the SPX combined with a move in the
XAU/SPX ratio to near the top of its long-term channel would translate
into a rise to around 300 by the XAU.

We aren't forecasting moves to 1200 and
300 in the SPX and the XAU, respectively, over the next 12 months. These
numbers were only mentioned to indicate the XAU's upside potential. Our
forecast is simply that gold stocks, as represented by the XAU and the
HUI, will handily outperform the broad stock market over the coming year
and in the process achieve good absolute returns.